LEAN accounting. No, it is not about how to make your accounting department leaner through better eating habits (although being in the middle of year-end and tax season I would imagine good eating habits went right out of the window). What LEAN accounting is about is building a financial model and results around an accounting, control, measurement, and decision-making system that supports and enhances a company’s overall LEAN strategy. The intent of LEAN accounting is to provide financial information around LEAN economics; eliminate waste and grow the business. LEAN accounting is not an additional system but a replacement for traditional accounting and reporting. LEAN accounting is itself LEAN.
In manufacturing, traditional accounting measurements use terms such as “Purchase Price Variance,” “Overhead Absorption,” “Production Variance,” and “Standard Product Costs.” To the average employee on the shop floor, these terms mean nothing to them. Who has time to really understand what “Overhead Absorption” is when you have an order to complete and customer demand to meet. The goal of LEAN accounting is to eliminate the confusion by inserting simple language and understandable financial measurements that all employees can understand and buy into while also tracking key performance measurements and indicators at the value stream level.
One of the most basic ways to meet these goals and objectives of LEAN accounting is through a different way to look at the traditional profit and loss statement. The traditional model focuses on net profits, which is the profit reflected by operations after overhead is paid for. More precisely revenue minus costs equal net profit.[su_heading]Traditional P&L Format[/su_heading]
The LEAN accounting model looks at this in a much different manner focusing on the value stream profit. The value stream profit is defined as the profit provided by the value stream without overhead.[su_heading]LEAN P&L Format[/su_heading]
Traditional accounting and reporting methods focus on items such as unit costs. Those types of profit and loss statements tend to be confusing, misleading, and ultimately leading to poor decision making as true impacts of LEAN change are not being clearly identified. Using the above financial statements as an example, under the traditional accounting and reporting structure, net profit in month A appears to be better under a traditional model versus the LEAN model. However, those results are masked by changes in overhead absorption and other accounting related allocations to the manufacturing process. Under the LEAN model, the focus is on gross profit. Gross profit in month A, while lower than that reported on the traditional model, shows continued improvement into month B as compared to the traditional model. Under the LEAN model, costs are clearly delineated and understandable with the focus on the profit and loss statement around gross profit versus net profit, hence eliminating corporate allocations and overhead from the equation of the analysis of LEAN operations. By doing this, bad decisions around process and function are eliminated as good change around LEAN is occurring. What LEAN accounting and reporting does is focus on value such as lead times, quality, and capacity. Traditional accounting systems are not powerful enough for the LEAN environment.
The LEAN profit and loss statement is designed to be understood by everyone. It provides quick, understandable and timely information to all line personnel and management. It also separates value stream profit from financial accounting adjustments, which provides clearer and more precise information to make business decisions. Finally, this model provides more clear accountability for revenue, costs, and profits through more accurate and consistent cost information and controls. Overall this model builds a relationship between financial reporting and continuous improvement, i.e. eliminate waste – reduce actual costs.
In a future post we will discuss the use of box scores and their impact on financial performance in the LEAN accounting environment. For further information on this post, please contact David B. Blain, CPA, CVA – Partner and Industry Leader of the McKonly and Asbury Manufacturing and Distribution practice unit at firstname.lastname@example.org or visit www.LEANAccountants.com.